2018 Economic Outlook: Riding the wave of growth

With gross domestic product (GDP) growth elevating to the 3% range the final three quarters of last year, the U.S. economy is entering 2018 on the wave of a solid growth trend.

The new tax law features some of the most pro-growth tax cuts ever enacted. New tax rates for corporations should result in less money for Uncle Sam and more for company bottom lines, leading to double-digit earnings growth for 2018 compared to 2017.

Deregulation is also contributing to business confidence, which hopefully will translate into wage growth and business investment.

Investment and financing outlook

However, making strategic corporate decisions involving capital investments and hiring merely based on broad optimism about the tax cut’s economic impact is not advised. Each company’s unique circumstances and tailored profitability forecasts should, of course, dictate such choices.

In general, corporate liquidity had been strong for years prior to enactment of the Tax Cuts and Jobs Act. Therefore, the prospect of federal taxes taking a smaller bite out of corporate profits probably will not be a game-changer for many companies examining the financing opportunities for major investments. After all, borrowing costs remain relatively low.

On the other hand, stock buybacks made easier by the corporate tax cut, to the extent they push up stock valuations, may enable some corporations to raise fresh capital with new stock issuances down the road.

Interest rates and the Fed

The Federal Reserve hiked short-term interest rates three times in 2017 and barring any unexpected disruption to economic growth the Fed is expected to tighten three more times in 2018. After spending almost eight years at near-zero interest rates, it’s hard to think of the fed funds rate above 2%, but the market believes with an 80% probability that on Dec. 31, 2018, that’s where we will be.

A change of leadership occured at the Fed in February as Janet Yellen’s term as chairperson expired and she was replaced by Jerome Powell. In terms of approach and philosophy toward monetary policy, not much change is anticipated. One of the major differences between the two, however, is believed to be their thoughts on the banking system. While likely keeping many of the core reforms of the Dodd-Frank Act in place, many believe Powell will be more inclined to loosen some of the rules placed on small banks today as well as revise some of the trading rules governing big banks.

Inflation in 2018

Tax reform, combined with continued relative accommodative global monetary policy, should lend itself to an environment of better growth and an expectation of inflation. Given that, there is a high probability that we test 3% during 2018. The one caveat that keeps a lid on yields and likely prevents movement above 3% is the continued low rate environment that exists among developed countries across the globe.

Keep an eye out for trouble spots

Despite the strong outlook for growth, there are no guarantees that the economy won’t experience some bumps in the coming year. One doesn’t have to look far to spot potential trouble spots, including U.S. export markets.

For example, analysts have long expressed concerns about debt levels in China, where the distinction between government and business debt can be murky. Highly leveraged “too big to fail” Chinese corporations and financial institutions might not be permitted by the government to collapse, but widespread stumbling could quickly depress global trade.

In addition, although highly indebted European countries have largely been out of the news lately, unresolved structural weaknesses remain despite some progress. Bailout showdowns could be making headlines again this year or next. Political instability in Germany, the European Union’s economic backbone, is troubling to many EU members. And the unknown future repercussions of “Brexit” are causing heartburn on both sides of the English Channel.

Despite improved economic growth we remain in one of the weakest recoveries in history. The economy remains fragile and the amount of public and private debt as a percent of GDP is concerning and at some point has the potential to stifle growth. The environment is certainly positive but business owners and financial managers should be cognizant of these facts.

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